This disclosure relates generally to methods for providing financial services and more particularly to methods for measuring value-at-risk and profitability of hedging.
Referring to FIG. 1, long term fixed rate funding has been the preferred method of debt issuance in the municipal market. Over the last several years, municipalities have become more comfortable with the concept of issuing floating rate debt and using swaps to achieve a significantly lower cost of funds. To hedge this floating obligation, municipalities can swap out their floating rate obligations to a fixed coupon using the Bond Market Association Municipal Swap Index™ (hereinafter, “BMA”). The BMA is the principal benchmark for floating rate interest payments for tax-exempt issuers. The BMA is a national rate based on approximately 250 highgrade, seven-day tax-exempt variable demand obligation issues of $10 million or more.
Referring to FIG. 2, issuers have begun to use a Percentage of Libor (POL) to hedge their tax-exempt variable rate obligations as an alternative to the BMA. Libor (“London Interbank Offered Rate”) is a taxable rate used by banks for short term funding and is the most common, liquid index used in the swap market. The tax exempt equivalent rate is converted by taking one minus the marginal tax rate. If the marginal tax rate is 35%, tax-exempt yields should be at least 65% of taxable yields. This relationship generally holds in the more efficient short-end of the tax-exempt curve where the BMA has averaged approximately 66% over the last 10 years. Moving out on the yield curve, however, this ratio does not hold constant thus creating an arbitrage opportunity. Long term rates reflect less liquidity, more varied credits and most importantly, compensation for taking tax risk.
However, currently available systems do not provide adequate information regarding the risk existing in portfolios of POL swap hedges. Currently, available analysis tools are inadequate and often inhibit use of POL swap hedges.